Pricing Multi-Event-Triggered Catastrophe Bonds Based on a Copula–POT Model

• Published in: Risks (Basel) 2023-08, Vol.11 (8), p.151
• Main Authors: Tang, Yifan, Wen, Conghua, Ling, Chengxiu, Zhang, Yuqing
• Format: Article
• Language: English
• Subjects: ARMA model; Bonds; Capital markets; CAT bond pricing; Catastrophes; Catastrophes (Mathematics); CIR model; Design; Disasters; Earthquakes; extreme value theory; Moral hazard; nested Archimedean copula; Prices; Prices and rates; Pricing; Rain; Reinsurance; Retention; Securitization; Time series
• ISSN: 2227-9091; 2227-9091
• DOI: 10.3390/risks11080151

The constantly expanding losses caused by frequent natural disasters pose many challenges to the traditional catastrophe insurance market. The purpose of this paper is to develop an innovative and systemic trigger mechanism for pricing catastrophic bonds triggered by multiple events with an extreme dependence structure. Due to the bond’s low cashflow contingencies and the CAT bond’s high return, the multiple-event CAT bond may successfully transfer the catastrophe risk to the huge financial markets to meet the diversification of capital allocations for most potential investors. The designed hybrid trigger mechanism helps reduce the moral hazard and increase the bond’s attractiveness with a lower trigger likelihood, displaying the determinants of the wiped-off coupon and principal by both the magnitude and intensity of the natural disaster events involved. As the trigger indicators resulting from the potential catastrophic disaster might be associated with heavy-tailed margins, nested Archimedean copulas are introduced with marginal distributions modeled by a POT-GP distribution for excess data and common parametric models for moderate risks. To illustrate our theoretical pricing framework, we conduct an empirical analysis of pricing a three-event rainstorm CAT bond based on the resulting losses due to rainstorms in China during 2006–2020. Monte Carlo simulations are carried out to analyze the sensitivity of the rainstorm CAT bond price in trigger attachment levels, maturity date, catastrophe intensity, and numbers of trigger indicators.